CHAPTER 8

Behind the Supply Curve:

Inputs and Costs
<Review Slides>

PowerPoint Slides
by Can Erbil
2004 Worth Publishers, all rights reserved
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What you will learn in this chapter:
The relationship between quantity of inputs and
quantity of output
Why production is often subject to diminishing
returns to inputs
What the various forms of a firms costs are and
how they generate the firms marginal and average
cost curves
Why a firms costs may differ in the short run
versus the long run
How the firms technology of production can
generate economies of scale
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The Production Function

A production function is the relationship
between the quantity of inputs a firm uses and
the quantity of output it produces.

A fixed input is an input whose quantity is
fixed and cannot be varied.

A variable input is an input whose quantity the
firm can vary.
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Inputs and Output

The long run is the time period in which all inputs
can be varied.

The short run is the time period in which at least
one input is fixed.

The total product curve shows how the quantity
of output depends on the quantity of the variable
input, for a given quantity of the fixed input.

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Production Function and TP Curve for
George and Marthas Farm
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The marginal product of an input is the
additional quantity of output that is produced
by using one more unit of that input.

Marginal Product of Labor
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Diminishing Returns to an Input
There are diminishing returns to an input
when an increase in the quantity of that input,
holding the levels of all other inputs fixed, leads
to a decline in the marginal product of that input.

The following marginal product of labor curve
illustrates this concept clearly
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Marginal Product of Labor Curve
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Total Product, Marginal Product, and the
Fixed Input
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Total Cost Curve for George and Marthas
Farm
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From the Production Function to
Cost Curves

A fixed cost is a cost that does not depend on
the quantity of output produced. It is the cost of
the fixed input.

A variable cost is a cost that depends on the
quantity of output produced. It is the cost of the
variable input.


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Total Cost Curve
The total cost of producing a given quantity of
output is the sum of the fixed cost and the
variable cost of producing that quantity of
output.
TC=FC + VC

The total cost curve becomes steeper as more
output is produced due to diminishing returns.
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Definition of Marginal Cost
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Total Cost and Marginal Cost Curves for
Bens Boots
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Average Cost
Average total cost, often referred to simply as
average cost, is total cost divided by quantity
of output produced.
ATC = TC/Q
Average fixed cost is the fixed cost per unit of
output.
AFC = FC/Q
Average variable cost is the variable cost per
unit of output.
AVC = VC/Q



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The average total cost curve at Bens Boots is U-shaped. At low
levels of output, average total cost falls because the spreading
effect of falling average fixed cost dominates the diminishing
returns effect of rising average variable cost. At higher levels of
output, the opposite is true and average total cost rises.
Average Total Cost Curve for Bens Boots
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Putting the four curves together: Marginal
Cost and Average Cost Curves for Bens
Boots
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General principles that are always true
about a firms marginal and average
total cost curves:

At the minimum-cost output, average total cost
is equal to marginal cost.
At output less than the minimum-cost output,
marginal cost is less than average total cost
and average total cost is falling.
And at output greater than the minimum-cost
output, marginal cost is greater than average
total cost and average total cost is rising.
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The Relationship Between the Average
Total Cost and the Marginal Cost Curves
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Marginal cost curves do not always slope upward. The benefits of
specialization of labor can lead to increasing returns at first
represented by a downward-sloping marginal cost curve. Once
there are enough workers to permit specialization, however,
diminishing returns set in.
More Realistic Cost Curves
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Short-Run versus Long-Run Costs
In the short-run, fixed cost is completely
outside the control of a firm.

But all inputs are variable in the long-run:
fixed cost may also be varied. In the long
run a firms fixed cost becomes a variable it
can choose.
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There is a trade-off
between higher
fixed cost and lower
variable cost for
any given output
level, and vice
versa.
But as output goes
up, average total
cost is lower with
the higher amount
of fixed cost.
Choosing the
Level of Fixed
Cost for Bens
Boots
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The long-run average total cost curve shows
the relationship between output and average total
cost when fixed cost has been chosen to minimize
average total cost for each level of output.
The Long-Run Average Total Cost Curve
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Short-Run and Long-Run Average
Total Cost Curves
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Economies and Diseconomies of Scale
There are economies of scale when long-run
average total cost declines as output increases.
There are diseconomies of scale when long-
run average total cost increases as output
increases.
There are constant returns to scale when
long-run average total cost is constant as output
increases.
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The End of Chapter 8
coming attraction:
Chapter 9:
Perfect Competition and
the Supply Curve